Iceland Mortgage Bank HFF Sees Bailout Averting Default

Residential buildings are seen on the city skyline in Reykjavik, Iceland. Photographer: Arnaldur Halldorsson/Bloomberg

Feb. 21 (Bloomberg) -- Iceland biggest mortgage bank said
the government would bail out the lender before it’s unable to
honor its debts.

“There’s no risk of a default,” Sigurdur Jon Bjornsson,
chief financial officer of the Reykjavik-based Housing Financing
Fund, said in an interview late yesterday. “The Treasury, if it
needed to, would bail out the fund.”

His comments were echoed by Finance Minister Katrin
Juliusdottir today, who said the government is prepared to cover
the struggling fund, which yesterday was downgraded by Moody’s
Investors Service to junk. Moody’s cited a capital shortfall and
growing loan losses. The cut to Ba1 from Baa3 was also based on
HFF’s “full reliance on market funding,” Moody’s said.

“We were fully aware during the budget discussion last
fall that the Housing Finance Fund was in trouble, but we also
stated that the Treasury would back the fund,” Juliusdottir
said at the Reykjavik-based parliament today. “Authorization
has been granted to inject new equity into” the lender. “So
we’re on the right path with the Housing Finance Fund.”

Iceland, which let its biggest banks default on $85 billion
in 2008, said in November it’s ready to inject 13 billion kronur
($100 million) into state-backed HFF to keep the lender afloat.
Yet even taking that support into account, the bank’s capital
ratio was about 3 percent of its risk-weighted assets at the end
of last year, compared with a 5 percent regulatory minimum,
Moody’s said. HFF had $4 billion outstanding in bonds at the end
of January.

The lender, which provides mortgages that are linked to the
inflation rate, is losing business to commercial rivals such as
Arion Bank hf and Islandsbanki hf, which are unfettered by such
indexation. As inflation hovers above 4 percent, borrowers have
turned away from HFF and sought alternative home loans to
prevent their debt burdens growing with consumer prices.

The krona slid 0.1 percent to 172.08 per euro as of 8:44
a.m. in Reykjavik.

Being Watched

The mortgage lender’s fate is being watched by offshore
investors trapped by Iceland’s capital controls. Since the
nation imposed currency restrictions at the end of 2008,
investors have had few places to put their funds. HFF has
provided a liquid market for some of the $8 billion in offshore
kronur fenced in by the controls.

HFF’s assets are likely to continue to deteriorate, Moody’s
said yesterday. Though the fund enjoys a “high level of
support” from the government, its capital ratio sank to 1.4
percent from 2.3 percent in the first half of last year, Moody’s
said. According to Sigurdur Jon Bjornsson, HFF’s chief financial
officer, HFF’s small capital buffer doesn’t pose a threat to its
survival.

“We’re discussing a very large fund,” he said in a
telephone interview late yesterday. “In comparison with other
financial institutions it has lost about 5 percent of its
assets, while other asset portfolios were written down by
between 45 percent and 65 percent. These 5 percent aren’t enough
to bring down the fund.”

Executives Meeting

Bjornsson said HFF executives will meet today to discuss
“the downgrade and decide what we want to say about it.”

Moody’s earlier this month raised the government of
Iceland’s Baa3 rating to stable from negative as the island
emerges from its 2008 economic collapse. Iceland, which
completed a 33-month International Monetary Fund program in
August 2011, is now outgrowing much of Europe as it rebounds
from its deepest recession in six decades.

Five-year credit default swaps on debt issued by the
government in Reykjavik dropped to a low of 150 basis points
this week, compared with 237 basis points on Italian debt and
252 basis points on Spanish debt. At the height of its financial
crisis in 2008, default swaps on Iceland’s debt traded at 1,473
basis points. Moody’s rated Iceland Aaa until May 2008, five
months before its financial system collapsed.